Inflation targeting and exchange rate pass-through in India : an empirical investigation

This chapter attempts to examine the exchange rate pass-through (ERPT) to consumer prices under inflation targeting (IT) framework in India. The chapter uses monthly data from the period January 2011 to October 2019 for the empirical investigation. The vector auto-regression (VAR) model is employed with variables on exchange rate, oil price, output, policy interest rate, and consumer prices index for the empirical analysis. The sample period is subdivided under two scenarios, pre-inflation targeting period (January 2011–October 2015) and post-inflation targeting period (November 2015-October 2019). The study finds that there is a significant decline of exchange rate pass-through under inflation targeting regime as compared to its previous regime, i.e., the multiple indicator approach regime. This finding is in line with an important study in Indian context by Patra et al. (Non-linear, asymmetric and time-varying exchange rate pass-through: Recent evidence from India. Reserve Bank of India, Working paper (02/2018), Mumbai, 2018). The study also supports the Gagnon and Ihrig (International Journal of Finance and Economics 9:315–338, 2004) theory which maintains a decline in exchange rate pass-through under inflation targeting framework. The chapter suggests that the decline in exchange rate pass-through via imported inflation may be helpful for monetary policy to achieve the target of inflation in India.